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Friday, January 22, 2010

Note that this appeared on Seeking Alpha January 21, 2010 and was an enormously popular post. Rogers did comment in the comment thread under my post. It was only his third comment ever on Seeking Alpha.

The prevailing bullishness of investing in anything related to agriculture did not play out very well for Jim Rogers' followers in the year 2009. In Rogers' January 15th, 2010 CNBC interview, he was very humble about his "ability to time the markets" due to the failure of his recommendation to buy agricultural commodities a year ago. He remains bullish on agricultural commodities and fears food shortages. He also states that farmers will be unable to pay for fertilizer next year.

On July 12, my article 13 Agriculture Myths Busted: This Bubble Is Ready to Pop, listed my contrarian viewpoints counter to the agriculture bulls. These played out by the end of the year, despite the unpopularity of my position at the time. I based my predictions upon deflation driven factors. As I predicted, both farmland prices and agricultural commodities declined in 2009.

The Macro ViewYou cannot predict agricultural economics without taking into account the macro global economic picture. Right now, we are continuing to deleverage, with high unemployment and low growth. Anyone who can't see that is in denial. Anyone who sees growth as better than a "new normal" is in denial. To back up my outlook, I'll quote from Kenneth Rogoff, Carmen Reinhart, and John Hussman.

Rogoff and ReinhartThe studies by Rogoff and Reinhart in their book, This Time is Different, prove with historical evidence, that countries which have taken on too much debt, as have the U.S., U.K., Japan, and others, grow very slowly for many years. They've also shown that unless political will provides correct action, an ultimate end leading to sovereign default is likely, which can play out a number of ways in varying degrees.

When a nation's debt exceeds 60 percent of its GDP, its growth rate slows precipitously, the study found. When that ratio exceeds 90 percent, nations' economies barely grow, and can even contract. The U.S. national debt is at roughly 84 percent of the country's GDP, and it's projected to cross the authors' 90-percent threshold late this year or early next year.

John HussmanIn his latest report, John Hussman describes our nation's debt, and the logic behind his expectation of inflation taking off in the second half of this decade. He expects further deleveraging, but with commodities leading the inflationary way. This is a somewhat similar, alternative outlook to consider, as hyperinflation is considered a form of default.The Agriculture SectorThe U.S. farm sector is more intertwined with the world economy than ever. Now that I've painted my near term low or negative growth macro view, I will proceed to describe the current economic condition of agriculture in the U.S.

CommoditiesThe prevailing bullish views appear to be:

There is a rapidly growing global middle class and that means more demand for grain commodities, partly related to higher protein intake with greater affluence.

There are low inventories of global grain commodities.

Ethanol will continue to require ever more corn and possibly more soy for biodiesel.

If you understand my macro view expectation, the first point listed above about a growing global middle class is wrong. The opposite is more likely true. We are entering a time of declining middle class affluence. This would translate to a lower demand for grain commodities.

Regarding the inventory levels, I'm not sure where the misconception comes from that we have low global supplies in grains right now. I heard this on the PBS Nightly Business Report on January 19, 2010, by analyst Jerry Jordan of the Jordan Opportunity Fund, "We've got very low inventories in general, soy beans, corn and wheat globally, grains across the world, inventories are very low." And, on January 15, 2010, Jim Rogers told CNBC, "The fundamentals (for agriculture) have gotten better," he said. "The inventories are now at the lowest they've been in decades, not in years."

The fact is, according to the USDA, levels are high. Production has been very high, near record levels across the globe.

World inventories of corn, soybeans, rice and wheat will reach 482.3 million metric tons this year, up 8.3 percent from the prior year, according to the U.S. Department of Agriculture. Farmers around the world raised production after prices surged to records in 2008. The U.S. corn and soybean harvests were at all- time highs last year, the USDA said yesterday.

CornCorn ethanol is profitable only via the government agricultural policy of mandates and subsidies. Though it is difficult to predict the politics of ethanol, our budgetary constraints could start to play into policy. As interest rates head up this will become more evident. In addition, as the recent Massachusetts election proved, politics is changing rapidly and becoming less predictable. It is possible that fiscal conservatism will eliminate ethanol supports, making it unprofitable. Carbon emissions, and soil health and sustainability have also been questioned in ethanol production. Because of ethanol, corn prices follow oil prices. Input costs include diesel, fertilizer, seed, equipment, acreage rents and property taxes. Corn peaked at 788 in June 2008. It is now 368, down more than fifty percent from peak.

WheatThe wheat market in the U.S. is hurting because its higher prices aren't competing well in the global market. Thus, fewer wheat acres will be planted next year in the U.S., the lowest since 1991. Those acres will be planted in corn and soybeans instead. From the USDA, "Global wheat supplies for 2009/10 are projected 2.5 million tons higher, mostly reflecting an increase in reported output by Russia."

SoybeansThough purchases from China have been strong, the U.S., Brazil and Argentina are all expecting large harvests. RiceWorld ending stocks are projected at 90.7 million tons, down 1.75 million tons from 2008/09.

Big Ag Corporations: Fertilizer, Seeds, Equipment, ProcessingAs we experience further deleveraging throughout 2010, I'd expect general equity markets to decline in a future double dip, including most of the agricultural corporations.

Farmland ValuesSo far, from their 2007 peak, farmland prices are down an average of seven percent in the U.S. Although I continue to expect weakness and declines in farmland prices over the next several years, if one is willing to hold land as an investment for the long term, as inflation takes hold, one should be able to recoup declining values experienced in the short term. Risks to consider would be that we are entering an era of "Japanese-style" deflation ending in a debt crisis. Land ownership regulations could change during a crisis and property taxes on land could go up considerably. Farm policy dictating direct government payments will ultimately determine agricultural profitability, and this nation is currently in fiscally uncharted waters where winners and losers are being picked unpredictably. Don't forget that there is an enormous amount of overproduction of grain at present in the U.S. Buyer beware. I have written extensively on farmland valuation factors to consider here on Seeking Alpha during 2009. Please reference those articles, if desired.

Currency valuationsAnother wild-card when predicting agricultural commodities is where the dollar is headed. It is possible that it will strengthen in a flight to safety as defaults and future deleveraging takes place. Increased dollar strength could erode U.S. grain commodity prices in the short term.

Growing stockpiles of the crops in the United States and other parts of the world bode for lower prices, analysts said. "There is considerable downside risk for prices through 2010," said Brian Basting, analyst for Advance Trading.

Though producers within the agricultural sector have maintained relative strength so far during this economic crisis and deleveraging, there is weakness throughout. Many are drawing down savings to operate, and for others credit is difficult to obtain. Some outside job sources have disappeared, and health care costs are a problem for the small rural producers. According to the USDA, net farm incomes in 2009 were down 34 percent. Global competition for inputs of fuel, seed, and fertilizer is driving input costs up. The less affluent global consumer is spending less on food. Meat purchases are less, dairy and cheese have been hurt considerably, and there has been less demand for grain commodities.

So, Mr. Rogers, grain stocks are not low. They are more than adequate. Thus, grain commodity prices are low, and given the macroeconomic picture, they may well be headed lower. This will likely be the trend throughout 2010 and possibly one to two years longer.

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ADDENDUM:

After I wrote the above article, I received an email from a fellow blogger friend who wrote this note:

I saw the SA article - it was great! It seems like I have the same conversation once a week with someone online about grain stocks, etc. The de Carbonnell article on 'Food Armageddon' was absolute, sensationalistic crap with no redeeming value whatsoever........I concede that we could have a global crop failure this year, and the Sun could go supernova too. But de Carbonnell offered no applicable data to make his case. And rather than debate the accuracy of U.S. Government stats (it's a given they can be pretty poor), I merely point to Ag Futures prices. They're not doing much - end of story. I used to work on the CBT floor. The private forecasters are big business. Their surveys are extremely thorough. If there were shortages looming, they would know and prices would be rising. Accumulating futures positions in Ags will move the market as they're relatively small.....The Rogers trade is a demand growth story - 75 million (and growing) net new mouths to feed per year. But as you point out, a deflating environment will reduce demand for the number one consumer of grain - livestock.